Financial Risk Manager Part 1
Get started today
Ultimate access to all questions.
A junior analyst has been given the responsibility of suggesting potential metrics that could enhance the bank's capital management strategy. As part of this task, the analyst needs to prepare a presentation that discusses the advantages and disadvantages of the Risk-Adjusted Return on Capital (RAROC) metric. Which of the following statements would be most appropriate to include in this presentation?
Exam-Like
A
RAROC will make it easier to compare the profitability of business divisions that require different levels of capital.
B
RAROC allows the firm to benchmark its performance against operating targets set by industry peers.
C
RAROC is an effective forward-looking tool to model potential extreme losses during stress scenarios.
D
An activity is adding value to the bank's shareholders if its cost of equity capital is higher than its RAROC.
Explanation:
A is correct. RAROC allows firms to compare the profitability of business lines that require different amounts of economic capital. B is incorrect. RAROC does not provide a benchmark against a peer group; rather it assesses if internal projects or business units are providing value to the firm (i.e. providing risk-adjusted returns higher than the firm's cost of equity capital). C is incorrect. RAROC uses an expected return but does not quantify losses during stress scenarios; other metrics such as expected loss or methods such as scenario analysis are more useful in assessing potential extreme losses during stress situations. D is incorrect. The activity is adding value if its RAROC is higher than the cost of equity capital.
Comments
Loading comments...